International Strategy and Organization Part II International Licensing

International Strategy and Organization Part II: International Licensing, Joint Ventures, Consortia, Franchising, Mergers & Acquisitions, Clusters and Counter Trade Josef Windsperger Professor of Organization and Management 1

Content 3 Management of Networks of the MNC 3. 1 Theoretical Foundation of Networks of the MNC 3. 2 International Licensing 3. 3 International Strategic Alliances, Joint Ventures and Consortia 3. 4 Internationalization through Franchising 3. 5 Internationalization through M&As 3. 6 Internationalization through Clusters 3. 7 Internationalization through Counter Trade 3. 8 Organization Design of the MNC of the Future 2

3. 1 Theoretical Foundations of Networks Hierarchy Stable Network Internal Network One Firm Dynamic Network Several Firms 3

Networks of the MNC Joint Venture High Consortium Countertrade Interaction Level Franchising Cluster Cross. Licensing Cooperation low Competition Cooperation Propensity Cooperation 4

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Theories of Networks Transaction Cost Theory Property Rights-Theory Resource-based Theory Relational View 7

3. 1. 1 Transaction Cost Theory O. E. Williamson (1975) Atmosphere Bounded Rationality Uncertainty/Complexity ‚Transaction Costs‘ Opportunism Transaction Specifity 8

Quasi-Rents, Specific Investments and Hold-up g BA A B g AB D g AC g BD C B‘s profit with A: g. BA A‘s profit with B: g. AB A‘s quasi-rent: QRAB = (g. AB – g. AC) B‘s quasi-rent: QRBA = (g. BA – g. BD) Quasi-rent of A (QRBA) = HOLD-UP Potential of B (HB) 9

Transaction Costs and Networks TC Market Network S 1 S 2 Hierarchy S 3 Specifity, Uncertainty Complexity 10 of Know How

3. 1. 2 Property Rights-Theory a. the right to use the good b. the right to change the good c. the right to capture the profit or to bear the loss d. the right to sell the good and to receive the liquidation value a + b = decision rights c + d = ownership rights Contractability (due to intangibility) of assets determines the structure of residual rights 11

Example: Franchising-Network Intangible assets of the franchisor: Brand name assets, system-specific know-how Intangible assets of the franchisee: Outlet-specific knowledge ao and a 1 are contactible – market coordination ao and a 1 are noncontractible – network coordination 12

3. 1. 3 Resource-based Theory Strategic Rents (SR) = Competitive Advantage (Schumpeterian and Ricaridian Rents) Organizational Capabilities Resources 13

Resource Characteristics Intangible, tangible resources and organizational capabilities Heterogenity Imitability Substitutability Firm specifity 14

3. 1. 4 Relational View: Networks and Trust g BA A B g AB D g AC g BD C B‘s Reputation capital: RB A‘s Reputation capital: RA A‘s Quasi-Rents: QRAB = (g. AB – g. AC) B‘s Quasi-Rents: QRBA = (g. BA – g. BD) Quasi-Rents of A (QRAB) + reputation capital of A (RA) A> H cooperative behavior A< H opportunistic behavior 15

3. 2 International Licensing agreement A company (licencee) is allowed to use the licensor‘s trademark, patent, manufacturing process or some other value creating activity of the licensor. Objectives (a) In-licencing: Access to complementary assets (b) Out-licensing: Risk reduction, deterrence of potential competitors, standard creation Cross Licensing Agreement on the exchange of rights for the entire portfolio of technology for a certain time period. Licensee pays fixed fees and/or royalties (percentage of sales) 16

Conditions for Licensing u Complementary and contractible resources Resources • easy to replicate (contractible) • property rights are well defined 17

TC and Licensing TC Hierarchy: FDI Licensing S 1 S 2 S 3 Specific Investment Know-how Complexity 18 Uncertainty

Property Rights-Explanation Contractible Know-how Market Contract A Non-contractible Know-how B to A: Licensing B Noncontractible Know-how A to B: Licensing Network Austrian company A wants to enter the market in Ukraine. The Company B in Chernivtsi has intangible knowledge at the consumer and labour market. On the other hand, the know-how of A is contractible. 19

Licensing as a Strategy for Technological Innovations 20

Country Culture and Licensing u Does the national culture influence the choice between licensing and foreign direct investments? “The national differences in levels of trust impact the choice of foreign market entry mode” (Shane, 1994) u Results - High Trust Countries → Licensing - Low Trust Countries → Foreign Direct Investment “Resorting to hierarchies is less common where trust among people is greater. ” (Shane, 1994) 21

3. 3 International Joint Ventures, Strategic Alliances and Consortia as stable Networks Joint Venture A B b a JV Strategic alliance a, b A B 22

3. 3. 1 Joint Ventures – Strategic Alliances Strategic Alliance: Agreement to gain competitive advantage through access to partner’s resources, including markets, technologies, capital and human resources. Joint Venture a. Scale JV: Firms enter together into a stage of production, distribution or a new market (for example: JV that produce components for automobile producers). Objective: Economies of Scale b. Link JV: Firms combine resources and capabilities from different stages of the value chain. Objective: Synergies in R&D, production, distribution, marketing. 23

JV and Strategic Alliances as Stable Networks Characteristics: – High specific investments, high uncertainty and/or – Complementary firm-specific resources and organizational capabilities – Joint Ventures: Allocation of decision and ownership rights – Strategic alliances: Allocation of decision rights, no ownership rights – Weak Ties: Trust instead of formal coordination mechanisms 24

Conditions for JV and SA Hennart 1988: „When knowledge is tacit, it cannot be effectively transferred in codified form; its exchange must rely on intimate human contact“ (366) - High TC: Markets for intermediate inputs are subject to high transaction costs due to high specific investments and high uncertainty, leading to a transfer of decision and ownership rights. - Firm-specific resources: The inputs are difficult to imitate by one of the parties. 25

TC, Licensing and Joint Venture TC Licensing S 1 S 2 Internal Hierarchy JV S 3 Specifity, Know-how Complexity, Uncertainty 26

Determinants of Decision and Ownership Rights in JV Hennart 1988: „When knowledge is tacit, it cannot be effectively transferred in codified form; its exchange must rely on intimate human contact“ (366) - According to the PR-theory, the contractibility of assets determines the governance structure. - Noncontractible assets require the transfer of decision and ownership rights. - Intangible assets refer to organizational, marketing, country -specific and technological know how. 27

Property Rights-Explanation Contractible Know-how Market Contract A Non-contractible Know-how B to A: Licensing B Noncontractible Know-how A to B: Licensing Joint Venture 28

Joint Venture: Choice of Entry Mode - Licensing - Joint venture - Wholly-owned subsidiary 29

Market Entry and Control u Licensing: low control u Joint Ventures: shared control u Subsidiary (WOS): Decision and ownership rights have the foreign headquarter 30

Market Entry and Resource Commitments Licensing: Low Joint Venture: Medium Wholly-owned Subsidiary: High Market Entry and Diffusion Risk Licensing: High Joint Venture: Medium Wholly-owned Subsidiary: Low 31

Eclectic Theory: Hill et al. 1990 Strategic Variables Environmental Variables 1. Scale Economies 1. Country Risks 2. Global Concentration 2. Cultural Distances 3. Market Potential 3. Demand Uncertainty 4. Competitive Dynamics Form of Market Entry Resource Variables 1. Value of the Firm-specific Knowhow 2. Tacit Knowledge of the Partner 3. International Experience 32

3. 3. 2 Consortia Latin „consortium“: association, society = a temporary collaboration to perform a certain task or to provide a specific service or product more efficiently = association of two or more individuals, companies, universities, or governments (or any combination) Separate legal status Control over each participant is generally limited to activities refering to the joint project 33

Consortium: New. PC-Consortium in Taiwan 34

Consortia versus Internalization Firms have to decide how much of the R&D they should be internally procured - not possible to procure all R&D from outside - in-house R&D is necessary for implementation This decision depends on a number of factors: - transaction and disincentive costs - technological and organizational capabilities 35

Transaction Cost Explanation u Organization has to balance transaction costs with incentives – Firm is more likely to integrate R&D activities (inhouse) where transaction costs are high – Firm is more likely to procure R&D from external partners where incentives can be enhanced with market competition 36

Organizational Capability Theory (1) Schumpeter (1912, 1942) and Penrose (1959) (resource based view) capabilities of the firm result in competitive advantages capabilities have to be enhanced through innovation and learning 37

Organizational Capability Theory (2) u R&D transactions: companies acquire scientific knowledge from outside and form alliances with other firms with different capabilities. Organizational Capability theory - lack of knowledge and sufficient capabilities of the firms - advantage of utilizing the new capabilities of external partners can exceed the coordinaton cost disadvantages. 38

Sakakibara‘s Model Motives for Consortia Economic View Cost-sharing Motives – – symmetrical firms in terms of capabilities or knowledge same industry & outcome Organizational View Skill-Sharing Motives – – – heterogeneous capabilities direct competitors in the product market knowledge base tacit knowledge difficult to transmit complementary knowledge 39

Sakakibara‘s Model Summary Motives Cost-sharing Skill-sharing competition in R&D single-industry consortia competition wide industry participation firm capabilities in R&D consortia homogeneous, substitutable heterogeneous, complementary role of R&D consortia private R&D spending divide tasks can decrease create/transfer knowledge can increase constraints firms face financial resources research capabilities 40

3. 4 Internationalization through Franchising. Networks Royalties to t Franchisor: System-specific Know-how Franchisee: Initial Fee Specific Investments Characteristics: -Franchisees and franchisor are entrepreneurs. - Intangible Assets: Franchisor‘s brand name, system-specific know how Franchisee‘s local market know how -Incentive system: Royalties and intial fees 41

Transaction Cost Theory TC Licensing Company-owned Franchising subsidiaríes ‚Hostage Model‘ S 1 S 2 S 3 Specifity, Uncertainty 42

A Property Rights View Intangible assets System-specific und local market knowledge H 1 How is the knowledge distrubuted Between the franchisor and the franchisee? Residual decision rights H 2 Who is the residual decision maker (whose decisions influences the residual income)? Ownership rights (Residual income rights) Proportion of company-owned Outlets (PCO) H 3 Royalties/ Initial Fees How are the ownership rights allocated? 43

Entry Forms 44

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Determinants of the Market Entry Choice: Environmental and Organisational Factors - Geographic distance - Cultural distance Country risk Political risk Market volume and growth - Resources of the partner - Brand name assets - International experience - Financial situation of the franchisor 46

Efficiency Comparison Subsidiary (WOS) 1. High resource commitments 2. Central control 3. Protection of the system-specific know how Appropriate: – – – High cultural and geographic distance Strong brand name Important system-specific know how High market potential and growth International experience 47

Area Development Agreement 1. Lower resource commitment 2. Relatively strong central control 3. Fast market entry Appropriate: – – – High geographic and cultural distances Uncertain market development Instable legal environment Local market knowledge is very important No international experience 48

Direct Franchising High control and agency costs Appropriate: – Low geographic and cultural differences – Strong local market know how of the franchisees – Relatively small market potential and growth 49

Joint Venture 1. Shared control 2. Know-how diffusion risk 3. Lower risk Appropriate: – Franchisor has not enough local market knowledge – Uncertain market development – High legal and political uncertainty – Relatively high cultural differences – Legal barriers 50

Master Franchising Lower central control Appropriate: – – – High geografic and cultural differences No international experience High political risk Strong market growth High market uncertainty Local market know-how is very important. 51

3. 5 Mergers & Acquisitions Merger Waves 110000 9000 2000: 10. 952 # of cases With US-firm involvements (5) Globalization, Single European Market, Shareholder Value Internet 8000 7000 93 -? ? 6000 5000 4000 3000 2000 1999: 9. 218 (1) „Industrial Revolution" leads to monopolies 97 -04 (3) “Conglomerate era" due to diversification theory (2) New Anti-trust laws leads to vertical integrations 65 -69 (4) “Merger mania", liberalization and deregulation 2001: 9. 614 2002: 8. 423 30. 09. 2003: 5. 444 84 -89 16 -29 1000 0 1895 00 05 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 00 05 52 Source: 1895 -1920: Nelson (1959); 1921 -1939: Thorp/Crowder (1941), 1940 -1962: FTC (1971, 1972), 1963 -99: Merger. Stat Review, 2000 -03: Thomson Financial, FH Zwickau

Mergers and Diversification Strategies (1) u Unrelated M&A: Conglomerate Mergers – NPV(A+B) = NPV(A) + NPV(B) – P = NPV(A+B) – NPV(A) – Only generates normal economic profit u Related M&A: Vertical and Horizontal Integration NPV(A+B) > NPV(A) + NPV(B) M&A generate strategic rents NPV = Synergies – Premium (preacquisition value – paid price) 53

Mergers and Diversification Strategies (2) u NVP(A) = 15000; NVP(B) = 10000 u Unrelated M&A: Conglomerate Mergers – NPV(A+B) = NPV(A) + NPV(B) = 25000 – P = NPV(A+B) – NPV(A) = 10000 – Only generates normal economic profit u Related M&A: Vertical and Horizontal Integration – NPV(A+B) = 30000 > NPV(A) + NPV(B) – P = NPV(A+B) – NPV(A) = 15000 M&A generate strategic rents 54

Lubatkin (1983) Technical economies (functional and management synergies) marketing, production, organization, scheduling, and compensation Pecuniary economies dictate prices by exerting market power Diversification economies (financial synergies) portfolio management and risk reduction 55

Jensen & Ruback 1983 (1) The reduction of production/distribution/coordination costs: 1. Through economies of scale 2. Through the adoption of more efficient production or organizational technology 3. Through the increased utilization of the bidder’s management team 4. Through a reduction of agency costs 56

Jensen & Ruback 1983 (2) Financial Motivations: 1. To avoid bankruptcy costs 1. To increase leverage opportunities 1. To gain tax advantages To gain power in product markets To eliminate inefficient target management 57

Target Firm’s Responses against the Bidding Firm u Greenmail: target firm purchases any of its stock owned by a bidding firm for a price which is greater than the current market price. u Poison Pills: any action of a target firm that makes the acquisition very costly, e. g. issue rights for the current stockholders for a special cash dividend in the case of a unfriendly take-over. u Crown jewel sale: target sells parts of the company, which are most profitable for the bidding firm. 58

Postmerger Integration Model Combination potential + Synergy realization + - + Organizational integration + + Employees‘ resistance 59

Combination Potential u. Economies of scale – similar operations u. Operational synergies u. Administration synergies u. Managerial synergies u. Financial synergies 60

Employee Resistance u M&As affect career plans u M&As create appearance of psychological problems such as: – “We versus they” antagonism – Distrust, Tension and Hostility u Cultural problems 61

Factors influencing integration u Management style similarity – Attenuates employee resistance – Cushions the degree of change and enhances organizational integration u Cross-border Combination – Impede the interaction and coordination because of country differences – Culture clashes promoting employee resistance u Relative Size – Insufficient managerial attention to smaller targets – Positively associated with organizational integration 62

Hypotheses • The higher the combination potential, the larger the synergy realisation. • The stronger the organizational integration, the larger the synergy realisation. • The higher the employee resistance, the lower the synergy realisation. • The higher the combination potential, the greater the organizational integration. • The higher the combination potential, the larger the employee resistance. • The greater the organizational integration, the larger the employee resistance. 63

Networks and M&As a. Alliances versus M&A u u u Alliances allow simultaneous and fast entering into multiple countries Both achieve complementary capabilities and/or economies of scale effects Alliances have a lower degree of organizational integration than acquisitions In alliances all decisions must be made by consensus among the partner firms Alliances are more flexible to adjust to environmental changes Alliances result in higher knowledge spill-over risks 64

b. Acquisitions versus Greenfield Investments Advantages of greenfield investments: - Know-how advantage of the MNC (ownership-specific advantages) - High market potential - Long-term market growth - Few competitiors - Stable legal and political institutional factors 65

c. Greenfield/Brownfield Investment/Acquisition Mode Choice Preference for external expansion Preference for internal expansion (greenfield) (acquisition) The acquired foreign firm has sufficient resources? no yes A B Critical resources are freely available at the foreign market. yes G no B 66

Impact of International Strategy on the Market Entry Mode (1) Global and multidomestic strategies are associated with different types of firm-specific advantages (FSAs): 1. location-bound FSAs 2. Nonlocation bound FSAs Global companies: exploitation of nonlocation-bound home based firm-specific advantages Multidomestic companies: exploitation of location-bound FSAs using host country specific advantages 67

International Strategy: Impact on M&A and Network Form (2) u Hypotheses: - Companies following Global Strategy higher proportion of Greenfield Investments - Companies following Multidomestic Strategy higher proportion of Acquisitions and Alliances 68

3. 6 Internationalization through Clusters Porter‘s Diamond Model Firm Strategy, Structure and Rivalry Demand Conditions Factor Conditions Related and Supporting Industries Government 69

Competitive Advantage through Clusters „Clusters are geographic concentrations of interconnected companies and institutions in a particular field. “ (Michael E. Porter) u u u They include an array of linked industries and other entities important to competition. Many clusters include governmental and other institutions that provide specialized training, education, information, research and technical support. Clusters can be extended downstream, horizontally and laterally. 70

Organisation Design of Clusters u u Characteristics: – Stable network based on the core competencies of partner firms – Location-bound – Institutional support Configuration: – Less formal coordination - Exclusive brand name at the market - Stable pool of cooperation partners Soft Integration Factors: – Trust as coordination mechanism IT-supported network relations 71

Evolution of Clusters Birth historical circumstances; unusual local demand; existence of supplier industry and related industries; a couple of innovative companies stimulate others. Evolution influence of government and other institutions expands; new entrepreneurs are attracted; suppliers emerge; information accumulates; infrastructure is improved. Decline technological discontinuities; a shift in buyer‘s needs 72

Advantages of Clusters (1) (A) Access to employees and suppliers u Can recruit from a pool of specialized and experienced employees lowers search and transactions costs u Offer a specialized supplier network minimizes the need for inventory eliminates delays lowers the opportunism risk and coordination costs 73

Advantages of Clusters (2) (B) Preferred access to specialized information u Extensive market, technical and competitive information accumulates within a cluster (C) Access to institutions and public goods u Investments by government or other public institutions and universities can enhance a company’s productivity 74

Advantages of Clusters (3) (D) Higher motivation and easier performance measurement u Local rivalry is highly motivating u Peer pressure leads to competitive pressure u Easier to compare and measure performances because of local competition 75

Regional Objective: Creation of Location-specific Competitive Advantage Innovation und Know-How -Upgrading Strong local competition Suppliers with high capabilities Sophisticated demand Specific resources 76

3. 7 Internationalization through Countertrade - Explanation: Market failure at the international product and financial markets Advantages for the MNC: Realization of a higher market potential -Informal coordination mechanisms (reputation capital, trust) instead of formal coordination mechanisms 77

Forms of Counter Trade u Classical barter - Clearing arrangement - Switch Trading u Buy-Back u Counterpurchase u Offset 78

Use of Counter Trade 79

Barter Clearing arrangement: - purchase equal value of goods and services Switch-trading: - goods that are useless to the trading country can be sold or transferred to a third country 80

Advantages of Barter u To open new markets u To avoid protectionist barriers u To stimulate trade u To trade with the Second World 81

Advantages of Offsets u Secure competitive advantage u Increase local employment u Create alternative sources of financing u Transfer technology u Avoid taxes and tariffs 82

Counter Purchase u u u Two hard currency contracts Goods are taken back by the seller These goods are not those produced with the equipment sold. They are from a list which is set up by the importer. 83

Buy-Back u Transfer of technology, plant, equipment and technical assistance u Purchase of a certain percentage of the output u Long-term orientation 84

Buy-back-contract Example A producer of luxery products from France (F) sells a machine to a company in Ukraine in order to produce and sell these products in Ukraine. The Ukraine producer (U) cannot use these production technology for other products. Questions: a) Market contract between F and Ukraine b) Vertical integration c) Buy-back: The F-producer concludes a contract to buy a certain amount of product from the Ukraine producer. F U Market Contract: What is the problem? Buy-back: ‚double hostage effect‘ 85

Hostage Model of Countertrade (Williamson 1983; Hennart 1988) TC Licensing Countertrade Hierarchy: DI ‚Hostage-effect‘ S 1 S 2 S 3 Specifity, Uncertainty 86

3. 8 Organization Design of the ‘MNC of the Future’ Theses (based on expert interviews) I. Evolution of ‘virtual countries’ II. Evolution of networks 87

„Shifting Networks“ „Virtual Countries“ Processes External Internal Employment Ad hoc projects with independent partners Employees Marketing Partner-specific branding Umbrella branding Organization Self-organizing teams and Hierarchy with networks decentralized structures 88

Cases for Discussion Case Study: Joint Venture u The car producer ADOK uses the input goods A and B for the production of OMEGA. The following resources are given: u ADOK has firm-specific production know how in producing A but has now experience in producing B. u MAX has firm-specific advantages in developing and producing B. MAX has built up his ownership-specific advantages through high R&D-investments in the last decades. His capabilities are difficult to imitate by potential competitors. u In addition, the market environment is very uncertain; especially the technological uncertainty is very high because new competitors frequently enter the industry. A) Which organizational form should be used to produce B? (Market contract, joint venture between MAX and ADOK or internal production) B) Now we assume that MAX has no firm-specific advantages in B; in addition the market uncertainty is relatively low. Which organizational decision should be made by ADOK in this situation? C) Assume that ADOK is in Germany and MAX in Bulgaria? Does this influence the organization decision for ADOK and why? 89

Case: Joint Venture, Acquisition and Greenfield Investment ALPHA want to enter the following markets: Market A: Characteristics: High market uncertainty, high market potential and growth, unstable political and legal institutional structure, high cultural differences. In addition, the competitors in the host country have high local market advantages (knowledge of the product and labour market). (1) ALPHA’S Market entry decision: Joint venture/acquisition/greenfield investment? Market B: Characteristics: Many competitors, no market entry barriers, high market potential and growth, longterm international experience. In addition, ALPHA has high competitive advantages in production and R&D. In addition, ALPHA’s organizational culture enables empowerment and decentralized decision making. (2) Which market entry strategy is efficient in this market? (3) Under which condition would you choose brownfield investment? 90

u Case: Discussion of Hypotheses – Market Entry in China: JV vs. Licensing u H 1: European companies (EC) which consider China as a high risk country are less likely to enter china through JV. H 2: The larger the cultural distance between EC firms’ home countries and China, the more likely they are to employ JV. H 3: The larger the political and economic distance between EC firms’ home countries and China, the less likely these firms are to employ JV. H 4: The greater the international experience of EC firms in China, the more they will employ JV. H 5: The larger the firm size, the more likely that firms will employ JV. H 6: When know how is of a tacit nature, it is more likely to be transferred through JV. H 7: The greater the transaction complexity and uncertainty, the greater the likelihood that firms will use JV. H 8: Firms employing a marketing mix strategy with standardized elements are more likely to use licensing. u u u u 91

u Case: Market Entry of Japanese Firms in US – Acquisitions vs. Greenfield Investments u Discuss: H 1: The greater the J-investor’s research and development intensity, the higher the probability of greenfield investments. H 2: The greater the J-investor’s experience in U. S. market, the higher the probability of acquisitions. H 3: The higher the rate of growth of demand in target market, the higher the incentive to enter through acquisitions. H 4: The lower the J-investor’s endowment in human resources, the higher the likelihood of acquisitions. H 5: The larger the size of subsidiary relative to that of the investor, the higher the probability of an acquisition. u u u 92